Earlier this week, I wrote about using a 529 plan to save for your child’s college. However, there is another tool that you can use to save for their college too. It is a Roth IRA.
Most people think a Roth IRA synonymous with retirement savings. And, that is true. It is most often used to save for retirement. But, it can also be used for college savings.
How does a Roth IRA work?
Basically, if you have earned income, you can make a contribution to an IRA up to $5,000 per spouse (or your earned income, if it’s less than $5,000 per spouse). Also, the amounts you can contribute are reduced if you have income between $159,000 to $169,000 if Married Filing Jointly (MFJ) and phased out above $169,000.
The amounts that you contribute to the Roth IRA are taxable (so you can’t deduct your contribution on your taxes like you can a traditional IRA). However, the money grows inside the Roth IRA tax-free. Then, when it comes time to pay for college, you can withdraw your contributions tax-free to pay for qualified higher education expenses, and you can withdraw any earnings penalty free (but you would have to pay tax on the earnings if you pull out the money before the owner is 59 1/2 and the account is open for less than 5 years).
What are some advantages of a Roth IRA over a 529 Plan?
- If your child does not attend college, you don’t have to worry about whom to give the account to avoid the 10% withdrawal penalty. You’ll just continue to let it sit in your account for retirement.
- You have greater choice where you save your money. The 529 plans are state specific, and many of them have fairly high fees. You can choose to open a Roth IRA and pretty much any financial institution.
What are some disadvantages of a Roth IRA over a 529 Plan?
- If you use your state 529 plan, you can deduct your contributions on your state tax return.
- Distributions from a 529 plan are completely tax-free (not just the contributions like the Roth IRA).
- Distributions from a Roth IRA would be included in the base-year income for financial aid the following year, and may reduce a financial aid need-based package.
- Annual contribution limits for the 529 plan are much higher than the Roth IRA for most states.
Of course, consult your own financial planner to determine which account is better for you. Plus, I would suggest that you focus mostly on your own retirement before you worry about saving money for college. Although not the best situation, your child can get student loans, but no one will give you a retirement loan.
Which plan do you use if you are saving for your child’s college? We personally have a 529 account for each of our boys as well as a UPromise 529 account. For more frugal ideas, please visit Life as Mom.
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